If Ex-Spouse Buys the House, No Taxes to Seller
Q: In a recent column, you discussed the tax consequences of selling the marital home after a divorce. You noted that if one spouse sells the house to the other, the gain received by the selling spouse is not taxable. Can you tell me more about this? My accountant says he is not familiar with this concept. --A.E.
A: Refer your accountant to Section 1041 of the Internal Revenue Code and its applicable regulations. In general, the section provides that if the marital home is sold “incident to the divorce,” the selling spouse does not have a taxable gain. However, the buying spouse keeps the original tax basis of the home, not the increased value based on the 50% sale.
Here’s how it would work. Let’s say you and your wife purchased the house for $100,000 and it is now worth $500,000. If you were not getting a divorce and you sold the house, there would be a $400,000 gain which would either be taxed or deferred. However, if you sell your half, worth $250,000, to your ex-wife--as part of the divorce settlement--you do not have a reportable gain because the IRS considers the deal a gift.
Such arrangements are typically great for the selling spouse. However, the buying spouse, while keeping the house, also keeps its original $100,000 taxable basis and does not receive a stepped-up value based on the price paid by the selling spouse. So when the buyer goes to sell several years later, perhaps for $600,000, he or she then would then have a gain of $500,000 on which to pay taxes or defer.
By the way, our experts say that because these deals are typically great for the seller and not so great for the buyer, price becomes highly negotiable. Generally, lawyers or tax accountants are needed to unravel the tax consequences.
Public Employees Get Partial Social Security
Q: I am a longtime employee of a federal agency under the civil service retirement program. I do not understand a statement you made in an earlier column that my Social Security benefits will be reduced because I receive a government pension. Please explain.-- D.A.C.
A: We are talking about what the government calls the “windfall elimination provision.” Congress designed this program to reduce the Social Security benefits of government employees already receiving a public agency pension and only minimally enrolled in the Social Security program.
Why? Because Congress felt that government employees could unfairly profit from the combination of both a government pension and Social Security benefits intended for a private-sector employee who worked at relatively low wages throughout his entire career. Remember, federal government and many other public agency workers do not belong to Social Security. Many public workers, however, take second jobs or become self-employed consultants for just long enough to meet the minimum enrollment qualifications for Social Security.
When it comes time to retire, these workers would be eligible for the Social Security benefit intended for the low-wage private-sector worker. This benefit is weighted to give this worker a greater return on his contributions than other more highly paid workers receive. So, Congress passed the “windfall elimination provision” to put government employees’ Social Security benefits more in line with what the nation’s other workers get.
One additional note: Although the windfall elimination provision reduces the Social Security benefits of a government pensioned retiree, it does not eliminate them. This is a marked difference from the “government pension offset” which can have the effect of eliminating the Social Security benefits a spouse would be entitled to receive if he or she were not already receiving a government pension. These are two separate programs with two entirely separate targets.
Tapping Into IRA Early Is Option for Disabled
Q: My husband, age 53 1/2, was disabled five years ago and cannot return to work. Because of this hardship, we are running out of money, and we are wondering what sort of options we have. We own a house. Is there any sort of ruling that would allow us to sell it now and still take advantage of the one-time tax exemption of $125,000 of the profits? What about our individual retirement accounts? Is there some sort of exception that would allow my husband to tap into his early because of his disability? --J.P.
A: The rules governing the exclusion of $125,000 worth of home sale profits from taxation are clear. One member of a married couple must be at least age 55; the house must be your primary residence and you must have lived there at least three of the last five years. No exceptions.
As for the IRAs, it may well be possible for your husband to begin drawing on his accounts without incuring the 10% early withdrawal penalty.
The key is that you must meet the definition of disabled, as set forth in Sect. 72 (m) (7) of the Internal Revenue Code. Basically, the code requires that a physician certify that the disabled taxpayer be unable to work due to a medical condition.
Purchase Date Dictates Stock’s Value as Gift
Q: I have been purchasing stock through a company dividend reinvestment plan every quarter. What purchase dates should I list on my tax return when I sell these shares? Also, how is the value of stock that is received as a gift established? --M.K.M.
A: When selling shares purchased through a dividend reinvestment plan, simply list the purchase dates and values included in the dividend statement you receive from the company each quarter.
These statements are quite explicit, usually listing the total monetary amount of your dividend, the purchase price of the company’s shares as of that date, and the number of shares your dividend entitled you to purchase.
This is the reason why everyone participating in dividend reinvestment programs should keep their quarterly dividend statements.
The value of stock received as a gift is its value as of the date the stock was purchased by the donor, plus any commission fees. So, if your mother gives you shares she purchased in 1950 for a total of $500, the base value of the stock to you is still $500, even though the stock may have a current trading value of $5,000 today.
However, if the stock is given to you upon the death of the owner, its value is that on the donor’s date of death.
